The Glade 4.0

Mervyn King, Governor of the Bank of England, fears that America shares many of the same fiscal problems currently haunting Europe. He also believes that European Union must become a federalised fiscal union (in other words with central power to tax and spend) if it is to survive. Just two of the nuggets from one of the most extraordinary press conferences I have been to at the Bank.
What with all the excitement yesterday over our new Government, I never had time to remark on the Inflation Report press conference. Most of our attention was on what King said about the Government’s fiscal plans (a ringing endorsement). But, as Jeremy Warner has written in today’s paper, it was as if King had suddenly been unleashed. Bear in mind King is usually one of the most guarded policymakers in both British and central banking circles. Not yesterday.
It isn’t often one has the opportunity to get such a blunt and straightforward insight into the thoughts of one of the world’s leading economic players. Most of this stuff usually stays behind closed doors, so it’s worth taking note of. And I suspect that while George Osborne will have been happy to hear his endorsement of the new Government’s policies, Barack Obama and the European leaders will have been far less pleased with his frank comments on their predicament.
The transcript and video are online at the Bank’s website, but below are the extended highlights, all emphasis mine. Well worth checking out.

America, and many other large economies including the UK, share some of the same problems as Greece with its public finances:

Every country around the world is in a similar position, even the United States; the world’s largest economy has a very large fiscal deficit. And one of the concerns in financial markets is clearly – how will this enormous stock of public debt be reduced over the next few years? And it’s very important that governments, both here and elsewhere, get to grips with this problem, have a clear approach and a very clear and credible approach to reducing the size of those deficits over, in our case, the lifetime of this parliament, in order to convince markets that they should be willing to continue to finance the very large sums of money that will be needed to be raised from financial markets over the next few years, at reasonable interest rates.

On why Europe will have to become a federalised fiscal union:

I do not want to comment on a particular measure by a particular country, but I do want to suggest that within the Euro Area it’s become very clear that there is a need for a fiscal union to make the Monetary Union work. But if that is to happen there needs to be also a mechanism to enable other countries that have lost competitiveness to regain competitiveness. That requires actions, probably structural reforms, changes in wages and prices, in the countries that need to regain competitiveness. But it also needs a solid and expansionary state of domestic demand in the stronger economies in Europe.

On the deficit:

The most important thing now is for the new government to deal with the challenge of the fiscal deficit. It is the single most pressing problem facing the United Kingdom; it will take a full parliament to deal with, and it is very important that measures are taken straight away to demonstrate the seriousness and the credibility of the commitment to dealing with that deficit.

Why it is right that the Government wants to cut spending as soon as this year:

We see the recovery beginning to take place, and we expect that the pace of that recovery will pick up. But we’ve also seen the market response in the past two weeks, where major investors around the world are asking themselves questions about the interest rate at which they are prepared to finance trillions of pounds of money that will need to be raised on financial markets in the next two to three years, to finance government requirements around the world. And that I think has been a sobering reflection of what can happen if you don’t make very clear at the outset – I think markets were not expecting any action before the election. After the election they need and they want a very clear, strong signal and evidence of the determination to make it work.
And I think that it’s quite difficult to make credible a commitment to fiscal consolidation if all the measures are somehow in the future. You need to start and get on with it….
I don’t believe that the scale of those measures, the £6bn cuts, is likely to be such as to dramatically change the outlook for growth this year. And as I said earlier in response to answers, I think it does reduce some of the downside risks by taking away some of the market risk that might have occurred if there’d been a sharp upward movement in yields.

On Greece:

I think the lesson from Greece is that, if the problem had been dealt with three months ago, it would not have become as serious as it subsequently became. And I think the important thing now is that Greece has been dealt with a major IMF and European Union package…
But those measures provide only a window of opportunity. They do not affect the total amount of debt, in themselves which countries around the world have to repay. The markets, which some of our European partners like to describe as speculators causing difficulty, are the very same markets where the public sector is looking to provide trillions of pounds of support to finance public debt around the major countries in the world over the next few years.
What matters is that those investors are prepared to buy government debt at interest rates which make it tolerable for the countries concerned. And that is why it is important for each and every country to demonstrate that they are on top of a programme for their country to reduce the fiscal deficit to a sustainable path.
That has been the big message, but within the international community I think there is a very clear understanding that the package of financial support which was made available at the weekend is not an underlying solution to the problem. It provides a window of opportunity which gives governments the chance to put their house in order; and it gives the international economic community a chance to talk about what I think – and have always said for some considerable time – to be one of the major issues facing us, which is the need to rebalance demand around the world economy.

On how worried international leaders are about the economy and Europe’s fiscal problems:

As you know international conversations proceed very slowly – too slowly usually. In 2008 there was an exception.
I think the mood and manner of the G7 meetings at the IMF in October 2008 was very different, and that people did come together and recognise that, unless they worked together, we would all be facing an extraordinarily serious position. That’s pretty well documented in Hank Paulson’s memoirs of the period.
But I think what I heard on the telephone conversations that I was part of at the weekend, it was slightly reminiscent of that: a recognition that the problems are far too serious for countries not to work together. After all, dealing with a banking crisis was difficult enough, but at least there were public sector balance sheets onto which the problems could be moved.
Once you move into the sphere of concerns about sovereign debt, there is no answer; there’s no backstop. And it is very important therefore that we hit these problems on the head now, put in place credible solutions to prevent the problems becoming worse.
And I detected at the weekend, in the conversations that I spent hours listening to on the telephone, that this sense of the need to work together was there again….
It is absolutely vital, absolutely vital, for governments to get on top of this problem. We cannot afford to allow concerns about sovereign debt to spread into a wider crisis dealing with sovereign debt. Dealing with a banking crisis was bad enough. This would be worse.

Why it’s too early to start raising UK interest rates, but not too early to be worried about inflation:

If you mean a tightening of monetary policy, then at some point it certainly will come. And when it comes it will be very welcome because it will be a sign of the strength of the UK economy, and the fact that we feel we will need to tighten monetary policy because we think the prospect for inflation is that it will not be to fall below the target as a result of so much spare capacity. So I think we would look forward to that time when it will come, because it will be a reflection of strength of the economy.
We’re not at that point now; I don’t know when it will come; that’s something we will judge month by month.
I can assure you the MPC is very concerned about what’s been happening to inflation. I do think that we have seen a sequence of shocks, price level shocks, which have inevitably raised inflation. We have also seen in the past three years two episodes now in which inflation did go up quite significantly and then came down quite sharply. And I think our judgement is that next year we will see a repeat of that. If these effects are not repeated, if we don’t see further increases in indirect taxes, or oil prices, then those shocks will not be there and inflation will start to come back and reflect the extent of spare capacity.

Fond words on former Chancellor Alistair Darling:

Perhaps I could take the opportunity of thanking Alistair Darling, and saying that I think that – for someone who became Chancellor and after only a few weeks the world’s greatest financial crisis took place – he has brought, not just domestically but internationally, a sense of calm and good humour which has made it much easier to deal with the problems that arose. And indeed, I think we had some rocky times, but we ended up with a very strong working relationship and in large part that’s because of the way he handled himself in the job.

Rather less fond words on former PM Gordon Brown:

I worked very closely with him late at night, weekends, to deal with the financial crisis. And I think when we both look back on our careers in many years to come, not now, many years to come, we will reflect that we probably had few opportunities to do something as important as the recapitalisation of the banking system in October 2008. It led, I think, the reaction of the rest of the world to that crisis. We worked incredibly closely on that. And I think that will seem a high point. And I very much valued the opportunity to work closely with Gordon Brown over many years as Chancellor and then Prime Minister. He had a remarkable period in office. And I wish him well in what I suspect is a career of which we may yet see more to come.